Rift between Merkel and Hollande

Eurozone crisis: Germany and France clash over eurobonds at summit

French president François Hollande marks his Brussels debut by challenging chancellor Angela Merkel over bailout

the Guardian,

24 May, 2012

A major rift has opened up between Germany and France for the

first time in 30 months of euro crisis over how to restore confidence

in the single currency.

A special EU summit marking the debut of France's President François Hollande saw him challenge Germany's chancellor, Angela Merkel, on the euro, arguing that the pooling of eurozone debt liability – eurobonds – had to be retained as an option for saving the currency. Merkel has ruled out eurobonds as illegal under current EU law.

Hollande told the dinner of 27 leaders that he wanted to see eurobonds established, while conceding that this would take time, witnesses at the talks said.

Merkel responded that this was nigh-on impossible since it would require changes to the German constitution and around 10 separate legal changes, the sources said.

There was no policy breakthrough at the summit, rather a reiteration by leaders of known positions. Any decisions were postponed until the end of next month after French and Greek parliamentary elections on 17 June.

The fissure between Paris and Berlin widened further when Hollande also called earlier for the eurozone's new bailout vehicle to be allowed to draw funds from the European Central Bank and to be able to recapitalise banks directly, both proposals fiercely resisted by Berlin and also currently impossible under EU law.

Senior German government officials had insisted that eurobonds should not be even discussed at the summit. The Hollande team maintained that all topics were on the table and also held open the prospect that France could refuse to ratify Merkel's fiscal pact compelling debt and deficit reduction in the eurozone unless eurobonds were recognised as a possible tool.

Officials said that the inconclusive meeting saw a shift in the balance of power towards the French, with supporters of Hollande's eurobonds demands increasing in number and becoming bolder.

The Franco-German clash was framed in terms of German-scripted austerity which has dominated two years of European response to debt crisis against a new French-led drive for growth policies at a time of record eurozone unemployment.

A series of marginal measures entailing use of EU budget funds and increased capital for the European Investment Bank to finance growth projects were criticised by economists and analysts as "a PR exercise". Hollande's advisers also said they were inadequate to the scale of the challenge confronting a eurozone which could unravel.

There was no final agreement on whether and how the extra capital for the EIB should be organised.

In what appeared to be a shot across the bows of the French, meanwhile, Germany's central bank warned for the first time that if the Greek crisis came to a head, Germany's and the eurozone's interests would be best served by Greece's exit from the currency.

According to Reuters, the 17 governments of the eurozone were told on Monday to draw up individual contingency plans for a Greek exit. The Greek government on Wednesday night denied that such an instruction was issued.

The Bundesbank in Frankfurt said that Greece was threatening to renege on the terms of its 130 billion euro bailout.

"The challenge this would create for the euro area and Germany would be considerable but manageable," the statement said. "By contrast, a significant dilution of existing agreements would damage confidence in all euro area agreements and treaties…calling into question the institutional status quo."

The timing of the Bundesbank warning appeared directed at Wednesday night's talks. It said that given the risks involved in bailing out Greece, eurozone governments should reconsider whether they should continue to provide a lifeline to Athens.

Merkel appeared rather isolated, while Hollande enjoyed the discreet support of the Spanish and Italian governments as well as of the European Commission which is now backing the drafting of a "road-map" on the medium-term prospects for eurobonds.

With Berlin and Paris looking seriously at odds, no hard decisions are expected until the end of next month. That suggests weeks of greater uncertainty and friction between Germany and France which will unsettle the financial markets.

Fresh from the G-8 summit outside Washington at the weekend, Hollande also sought to play the American card, referring to the efficacy of Brady bonds in the US in spurring economic growth. Merkel responded that eurobonds would "not make any contribution to stimulating growth."

It emerged that the Obama administration had sought at the weekend to "impose" a much tougher G-8 declaration on the crisis in the eurozone, but that Merkel had fiercely resisted and that the summit communique had to be rewritten as the US draft was too "awkward."

The growing international exasperation with the Europeans' halting response to the crisis is being echoed by the deputy prime minister, Nick Clegg.

In a speech in Berlin this evening he is expected to say that some world leaders "are saying behind capped hands that Europe is now congenitally incapable of exercising the leadership needed and it might be in everyone's interests if Greece left the Euro.

"We must build a firewall big enough and strong enough to stop the flames from spreading," Clegg said. Despite the reference to "we", Britain is not involved and refuses to take part in the rescue effort.

Senior EU officials also voiced exasperation with the recent rash of statements from David Cameron advising the eurozone what to do.

Mario Draghi, the head of the European Central Bank, used his summit platform to articulate the broad annoyance with Downing Street's comments on the euro crisis, officials said. "We couldn't care less what Cameron says," said another senior EU official.

Despite the differences between Paris and Berlin, Hollande and Merkel, say well-placed sources, are united in opposing a Greek exit from the euro in the belief that keeping Greece in will be hugely expensive but nonetheless much cheaper than letting it go. "There are too many unknowns," said another official.

But Merkel and Hollande disagree on tactics towards Greece, with the French favouring sending a signal on easing the schedule for Greek deficit reduction while the Germans believe this would encourage Athens to compromise on the austerity measures.